Monday, April 25, 2011

A big question that arises in California these days is whether the debt on your real estate is recourse or non-recourse. The difference can be quite significant if you are going through a foreclosure, deed in lieu of foreclosure, or a short sale. If the debt is non-recourse and you go through a foreclosure, deed in lieu of foreclosure, or a short sale, there is no potential for a deficiency on the loan and there is no income from any cancellation of debt. However, if the debt is recourse there is a potential for a deficiency and income from cancellation of debt. Recourse debt creates personal liability for the debtor for the portion of the debt that is not repaid to the lender. That is why this determination of recourse v. non-recourse is so important as an initial hurdle.

A note can be non-recourse if the contract that creates the debt indicates that it is a non-recourse note. Purchase money notes in California are also non-recourse by definition. A purchase money note is a note whereby the borrower borrowed money to purchase a principal residence and the funds went directly into escrow and then to the seller of the property for the purchase of a one to four unit property. Thus, seconds, HELOCS and Refinanced Loans on property would typically not be a purchase money note and would create personal liability in the event of a default on the note.

California has come to the rescue with SB 931 with regard to short sales. If a lender agrees to a short sale in writing in California the First Trust Deed on a one to four unit property is non-recourse and the lender can only look to the property for repayment. Notice that this Bill does not exclude rental properties. Therefore, if a borrower has a potential issue with a deficiency on a first trust deed, whether it is a rental or a principal residence, the borrower should attempt to short sale the property to avoid a deficiency judgment of the property. SB 931 does not work for foreclosures or deeds in lieu of foreclosure. It is only for short sales.

When you are disposing of distressed real estate there are numerous tax and legal issues that you must address and be aware of prior to closing the transaction. Make sure that you consult with a tax attorney to make sure you do not have any hidden costs that you will be later surprised by when it is too late.

Sunday, April 24, 2011

When you sell real property in a Short Sale Transaction there are numerous tax implications that you will want to consider. First, just what is a Short Sale. A short sale is when you sell a property and the sales proceeds are not sufficient to pay off the loan that you have on the property and you ask the lender to accept less than the full amount they are due to pay off the loan.

When you short sale a property the tax considerations revolve around two basic issues. First, the income from the cancellation of the debt, and next any gain that may have to be recognized on the sale. Cancellation of debt income occurs when you pay less than the full amount back to the lender. When you borrowed the money from the lender you did not have to pay tax on the borrowed money because you were obligated to pay back the debt. However, when the debt was canceled and you did not have to pay it back that is income. The lender will send you a 1099C informing you and the IRS of the canceled debt. You will also have to determine if there is a gain on the property you disposed of in the transaction. The IRS considers this disposition a sale and you must report the sale less the tax basis in the property. This could result in a gain if you have a low basis in the property and refinanced it pulling out cash.

The next thing that you need to consider is whether the income from the Cancellation of the Debt is actually taxable. There are four exclusions that must be considered. First, if the debt is non-recourse (as determined by state law) there can be no income from the cancellation of the debt; Second, if the home was your principal residence the debt is excluded up to $2,000,000 by the Mortgage Forgiveness Debt Relief Act of 2007; Third, if you are insolvent the cancellation of debt is forgiven to the extent that you are insolvent at the time the debt is forgiven; Fourth and finally, if you are bankrupt the cancellation of debt is forgiven if it was included in your petition.

The cancellation of debt and how you handled it for tax purposes is reported on Form 982 that is included with the filing of your form 1040. This is where you also adjust the basis for assets where debt was canceled.

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About Me

I am a Tax Attorney that is Certified as a Specialist by the State Bar of California. I am the founder of the Lively Law Group, a Tax Law Firm in Orange County, California. You can email me with any comments or questions at dlively@livelylawgroup.com. Any individual seeking legal advice for their own situation should retain their own legal counsel as this blog provides information that is general in nature and not specific to any person's unique situation. Circular 230 Disclaimer - Advice given in this Blog cannot be used to eliminate penalties with the IRS or any other governmental agency.